Did you know that it may be advantageous to file a gift tax return when transferring property to, or for the benefit of, a family member even when a gift tax return is not required? Transfers such as a sale to a family member or to a grantor trust, where the value of the item sold could be in dispute, are non-gifts that should be reported on a gift tax return. If a gift tax return is filed that meets the IRS' "adequate disclosure" requirements, the three-year statute of limitations clock starts.
Avoiding future tax surprises
Generally, the IRS has three years after a gift tax return is filed to challenge the value of a transaction for gift tax purposes or to assert that a non-gift was, in fact, a partial gift. However, there is no statute of limitations barring assessment if no gift tax return is filed, if the gift tax return is false or fraudulent, or if the gifts and non-gifts are not adequately disclosed on the gift tax return. That means the IRS can collect unpaid gift taxes, plus penalties and interest, years or even decades later.
Define adequate disclosure
If you file a gift tax return that meets the adequate disclosure requirements, the IRS has only three years in which to challenge the valuation. To fulfill these requirements a return must include:
- A description of the transferred property and any consideration received;
- The identity of, and relationship between, the transferor and each transferee;
- The trust's tax identification number and a brief description of its terms (or a copy of the trust instrument) if property is transferred to a trust;
- Either a detailed description of the method used to value the transferred property or a qualified appraisal (see "Benefits of a Qualified Appraisal" below); and
- A statement describing any position taken that is contrary to any proposed, temporary or final tax regulations or revenue rulings published at the time of the transfer.
However, for non-gifts
For non-gifts, adequate disclosure also requires the gift tax return to include an explanation as to why the transfer is not a transfer by gift under the Internal Revenue Code. However, it does not require a detailed description of the method used to value the transferred property or a qualified appraisal. But, in order to adequately explain why a transfer is not a gift, there should be support that the consideration paid was equal to fair market value of the property transferred. Therefore, even though it is not required, the gift tax return should include a detailed description of the method used to value the transferred property or a qualified appraisal.
Additional disclosure for transfers subject to the special valuation rules of Chapter 14
Transfers subject to the special valuation rules of Chapter 14, such as Grantor Retained Annuity Trusts (GRATs)—including zero gift GRATs— and Qualified Personal Residence Trusts (QPRTs), have the following additional disclosures requirements:
- A description of the transferred and retained interests and the methods used to value each;
- The identity of, and relationship between, the transferor, transferee, all other persons participating in the transactions and all parties related to the transferor holding an equity interest in any entity involved in the transaction; and
- A detailed description (including all actuarial factors and discount rates used) of the method used to determine the amount of the gift (if any) including, for equity interests that are not actively traded, the financial and other data used to determine value.
Benefits of a qualified appraisal
Obtaining an independent appraisal offers significant benefits, particularly for difficult-to-value property, such as interests in closely held businesses. An appraisal by a qualified appraiser helps ensure that the gift tax return contains all valuation information necessary to satisfy the adequate disclosure rules. Plus, if the appraisal is conducted at or near the time of the transfer, it will go a long way toward persuading the IRS that the original valuation of the property was accurate.
Speak to your advisor
You may be reluctant to file gift tax returns disclosing non-gift transactions for fear of drawing the IRS' attention. However, in some cases, it is advisable to file a timely gift tax return that satisfies the adequate disclosure requirements. Contact your estate planning advisor for more information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.